When milliseconds count

The latest flash point in Wall Street rocket science is something called “high frequency” trading. The trick to this is using high-speed computers to exploit asymmetrical information. As the New York Times explains:

When buy or sell orders are submitted to marketplaces like Nasdaq, they are sometimes flashed to a collection of high-frequency traders for just 30 milliseconds — 0.03 seconds — before they are routed to everyone else. In that half-second, fast-moving computer software can gain valuable insights regarding growing or declining demand in certain stocks, and can trade ahead of other market participants, pushing prices up or down.

Already Senator Chuck Schumer has called for an SEC ban while the financial services industry defended the practice. In his Washington Post column today, Steven Pearlstein (The Dust Hasn’t Settled on Wall Street, but History’s Already Repeating Itself) laments the practice:

But as far as I can tell, buying and selling huge volumes of securities in a matter of seconds is just another high-tech form of speculation that is only remotely connected to the fundamental purpose of financial markets, which is to raise and allocate capital efficiently for businesses that need it. Liquidity is certainly good for markets, but we recently learned from painful experience that it is also possible to have too much of it. And though sophisticated computer systems can be powerful tools in plotting trading strategies and managing risk, we also know that these systems have blind spots and can backfire when too many people try to pursue the same strategy at the same time.

I have a more fundamental question. I’m not a securities lawyer, but I thought the idea of one set of people having access to public information before others was forbidden. As Pearlstein notes:

Already, the Securities and Exchange Commission is preparing to clamp down on exchanges that, in return for special fees or guaranteed trading volume, provide certain hedge funds with access to some trading orders that come into its computers a fraction of a second before they are “posted” for everyone else. That’s just enough time for the hedge funds’ computers to detect patterns in the order flow and use that insight to trade ahead of other market participants.

It may be only milliseconds of access to the trading information before others have access to that information. But, in this case milliseconds can make a very big difference.

Welcome to the Information Age.

Those 2Q GDP numbers

So, this mornings GDP numbers from BEA ended up better than expected – down only 1% rather than the 1.5% drop forecast by the Dow Jones Newswires. On the other hand, the 1Q of 2009 was a much steeper decline of 6.4% (rather than the “final” estimate of 5.4% in 1Q 2009 and 6.3% in 4Q 2008).

Today’s numbers may be a good indicator — they are not necessarily the light at the end of the economic tunnel for many people. As the New York Times reports:

“We’re going from recession to recovery, but at least early on, it’s not going to feel like one,” said the chief economist at Moody’s Economy.com, Mark Zandi. “For economists, this is a seminal part in the business cycle, but for most Americans, it won’t mean much.”

What is remarkable to me is the size of the revisions. Today’s revisions essentially flip the story on economy over the winter. Before the data showed the biggest drop on 4Q 2008, with a smaller decline in 1Q 2009. Now the bigger drop is actually in 1Q 2009 with a smaller decline in 4Q 2008.

The revisions are even more striking when looking at the advanced and final estimate, compared with today’s revisions. Advanced estimate of 4Q 2008 GDP was -3.8%; final estimate was -6.3%. Today’s revised estimate is -5.4%. Advanced estimate of 1Q 2009 GDP was -6.1%; final estimate was -5.5%. Today’s revised estimate is -6.4%.

These revisions are due to ongoing work by the BEA to improve the numbers.

As a side note, the terminology about the various releases will be changed, to better reflect the continued refinements of the data. As BEA notes:

The three vintages of quarterly GDP estimates are renamed “advance” (no change); “second” (currently known as “preliminary”); and “third” (currently known as “final”).

So, treat the numbers with a bit of a grain of salt. Today’s data is subject to revision as well. The direction of the trend is good however. The real question is not so much the specifics of the data, but how to create a sustainable, non-bubble growth path for the economy.

Quick takes

Here are some recent interesting articles:
Innovation in a Recession. Business Week’s Special Report on “How companies are finding creative ways to come up with new products and services faster and more efficiently–with fewer resources.”
Book Review: Learning from Apple’s Design Consultant. A look at a new book on design from Hartmut Esslinger founder of the industrial design firm Frog — complete with case studies.
How Washington Can Jumpstart Entrepreneurship – Washington Monthly Special Report. An interesting overview essay followed by articles on the areas of innovation policy focus of the Obama Administration: broadband, green tech, smart energy grid, and health care technology.
Effective Corporate Tax Reform in the Global Innovation Economy – Rob Atkinson, Information Technology and Innovation Foundation. An unabashed advocacy for using tax policy as an industrial policy toll to promote innovation — including one of my favorite recommendations: the knowledge tax credit.
Creating a National Innovation Framework. Yet another call for an innovation policy — with a nice description of the various federal technology and financing programs.
Using Design to Drive Innovation – Business Week. This article argues that “Designers must deliver the orchestration of the total experience with a brand, product, or service or face irrelevancy.”
Bootstrapping High-Tech: Evidence from Three Emerging High Technology Metropolitan Areas – Brookings Institution. How cities without a major university can become high-tech nodes.
New Industry, New Jobs and Annual Innovation Report 2008. The UK’s plan for economic recovery and the latest update on their innovation policy.
The Pink Prescription: Facing Tomorrow’s Challenges Calls for Right-brain Thinking. An interview with the always insightful Dan Pink — including why doctors should study art.

Innovation after the bubble

David Ignatius has an insightful column in Sunday’s Washington Post – Life in the Rehab Economy. He talked about the slower rate of growth we can expect in the future as we move away the over-leveraged debt based consumption boom of the bubble:

It’s an economy in rehab, you might say, working off the excesses and imbalances that created the crash of 2008. Savings rates will remain high, as people try to protect themselves and their families from another market collapse; the chronic trade imbalances of the past several decades will ease, as Americans reduce their consumption of everything, including foreign imports. It’s a post-binge economy, cautious and careful — with a lower tolerance for risk and correspondingly lower rewards.

He also talks about downside such a risk-averse economy:

The danger with this comfortable, slow-growth world was that it didn’t adequately reward innovation and risk-taking. And that’s the worry I have about our rehab economy. Without big incentives, will innovators come up with the world-changing ideas, and will capital markets be resilient enough to finance them?
It’s a good rule never to bet against America, and in the long run it’s a certainty that America will innovate, grow and prosper. But over the next few years, America is likely to have stubbornly high unemployment, rising interest rates and disappointing investment returns in many sectors.
I keep reminding myself that the rehab economy is good for us: Higher saving, less debt, lower imports, less risky financial behavior. But we should be honest about the drawbacks of this new paradigm and, where possible, ameliorate them.

I’m not sure I see the decline of an over-leveraged economy as an era of less innovation, however. In part, I disagree that we need “big incentives” such as we saw in recent years — which in any event came in the form of the huge payouts to the financial sector not to business innovators. After all, Bill Gates didn’t need an over inflated housing market to become a multi-billionaire. “Big incentives” can lead to bubbles — dot-com, housing, etc. What we need are steady incentives – such as those that took a company like Washington DC based Blackboard from an idea of a couple of guys about education software in 1997 to one with over $300 million in revenues — even through the dot-com bubble.

Second, I disagree because the culture has changed. Innovation is much more imbedded in company’s operating procedures. The chance of returning to the day’s of the “man in the gray flannel suit” as Ignatius mentions are rather slim.

Still, his warning about ensuring that innovation continues is timely. We need an innovation policy in this country. In December, we published an outline of such a policy with our Working Paper Crafting an Obama Innovation Policy. The recommendations of the paper still hold.

Chief among them was to re-establish the President’s Council on Innovation and Competitiveness (PCIC). PCIC was created by Section 1006 of the America COMPETES Act of 2007 as a mechanism to “develop a comprehensive agenda for strengthening the innovation and competitiveness capabilities of the Federal Government, State governments, academia, and the private sector in the United States.” The statutory Chair of the Council is the Secretary of Commerce and is made up of the heads of 16 departments and agencies (a nonexclusive list). However, the Council has never met. The Bush Administration relegated this responsibility to the Committee on Technology (CoT) of the National Science and Technology Committee (NSTC) in Office of Science and Technology Policy (OSTP) – which established it as a Subcommittee. Essentially, the issue of innovation and competitiveness was relegated to a subcommittee of a committee of a committee.

The Obama Administration should raise the issue of innovation and competitiveness back up to the Cabinet level where it belongs. That would an important first step in ensuring that the post-bubble economy is truly an Innovation Economy.

Open innovation in Fashion Design

One of the hallmarks of the Intangible Economy is the shift in the innovation process. Central to that shift is the idea that innovation can come from anywhere — including users. While standard example of user-generated is mountain bikes, the concept can be found almost anywhere including pipe-hanging fixtures, printed circuit boards and surgical equipment (see Eric Von Hippel’s classic study The Sources of Innovation and his more recent Democratizing Innovation).

A new example comes from the fashion industry. Today’s New York Times has a story about open innovation in design:

Polyvore is a user-generated fashion magazine filled with user-generated ads. The people who go to it play fashion editor and create collages featuring pictures of clothes, accessories and models from across the Web. Readers view the collages, which the site calls “sets,” and if they click on a dress or necklace, they are taken to the Web site that sells it.

It has always struck me that fashion should be a prime area for user-driven innovation. After all, while top designers may dress the models, the day-to-day task assembling a wardrobe and of deciding what to wear is all user driven. Fashion pages (such as that in the Washington Post) often feature what is seen on the street — put together by the average person (an average person with good taste, of course).

So the business model behind Polyvore makes perfect sense to me. It will be interesting to see how many of those fashion pages copy it. In part, the Washington Post already has, by having readers post their own fashion photos. But such user generated content is still based on a publication model. Polyvore seems to go well beyond that to a retail model.

It is also a data mining model. As the story notes:

Polyvore also plans to sell data on customer preferences it compiles on the site. It could potentially tell a retailer that a type of shoe is more popular in Manhattan than Los Angeles, so it would know where to stock the shoe. Or designers could upload images of new items before deciding to produce them to get input from fashion-savvy users.
It could also give buyers information about trends in real-time, faster than monthly magazines, said Jess Lee, Polyvore’s product manager. This fall, for example, watch for recent trends bubbling up on the site: exposed zippers, fingerless gloves and butterfly prints.

Like any good user-driven innovation model, the process connects users with producers. Sound like a winner to me.

Design get White House attention

Today, the National Design Awards is holding a Design in D.C. day, with top level participation from the Obama Administration. About time — maybe next we can get them to focus on “design thinking” as well.
The session are at 10:00 am this morning and are being webcast live:
Details: Materials and their Effects
Francisco Costa (Fashion Design) and Calvin Tsao and Zack McKown (Interior Design) will discuss the role of material in their work, while sharing their visions, projects and inspirations with Ebs Burnough, White House deputy social secretary.
Community: Transform your Neighborhood
Neill McG. Coleman, general deputy assistant secretary, U.S. Department of Housing and Urban Development, will discuss how design can be used as a tool to create a sense of community with Christopher Sharples, Coren Sharples and Gregg Pasquarelli of SHoP Architects (Architecture Design) and Walter Hood (Landscape Design).
Information: Interpreting the Present and the Past
Anita Dunn, White House acting communications director, will discuss the relationship between current events and the design process with Boym Partners (Product Design) and The New York Times Graphics Department (Communication Design).
Experience: The Future of Interaction Design
Aneesh Chopra, U.S. chief technology officer, will discuss the future of interaction design with Jeff Han of Perceptive Pixel Inc. (Interaction Design) and Andrew Blauvelt of Walker Art Center (Corporate and Institutional Achievement).
Tomorrow: The Future of Technology and Sustainability
John Holdren, director of the Office of Science and Technology Policy in the Executive Office of the President, will discuss the future of technology and sustainability with Amory Lovins (Design Mind) and Bill Moggridge (Lifetime Achievement).

Slow down in IP auctions?

Joff Wild’s blog has a run-down of the first day of the ICAP Ocean Tomo auction — and the news is not good. Both sales and then number of patents auction are down significantly. Joff quotes Terry Ludlow of Chipworks summary:

If patents with clean provenance, limited licensing encumbrances and solid claim charts are offered, they still sell on the open market. But, no-one is buying speculatively. And, with the relatively high reserve bids published for the patents, most of the lots attracted no bids at all! The aggregators seem to have been entirely absent.

From what it sounds like, the bloom may be off the “IP-as-speculative-investment” rose. That may not be such a bad thing, however. If intangible assets can settle down as a solid asset class, then there is opportunity for sustainable growth in IA financing. But, as I worried about yesterday, if they remain “exotic” they are likely to remain a very small part of the financial markets. We need more vanilla and less Tabasco in this market.

Why we need gold-plated standards for intangible assets

One of the aspects of the recent (ongoing?) financial meltdown that has concerned me is the possible backlash against intangible assets. Most of us recognize that intangible assets are real and have value. But to the rest of the world, looking superficially, these may look like very “exotic” assets indeed. As I commented about the recent Morgan Stanley transaction, they can seem (and be) very risky.

They need not be. Done right, an intangible asset backed loan or securitization can reduce risk and free up capital by providing security collateral not otherwise utilized. An IA-based securitization can be structured to be much more transparent than the massively complex synthetic securitizations of previous years.

However, to the extent that we don’t have standards for ensuring transparency and guarding against the overly complex, intangible assets will be relegated to the “exotic”, and therefore dangerous, category.

So why does this matter? Can’t the market figure out the risk and act accordingly? From recent history, the answer is apparently not. This is where regulation comes in. And right now, the mood is anti-“exotic”. For example, in last night’s press conference President Obama went after these types of transactions. As the Wall Street Journal reports, (Obama Proposes New Transaction Fees for Financial Firms’ Riskiest Investments):

President Barack Obama said for the first time that the government might assess new fees against financial companies engaging in what he labeled “far-out transactions,” in order to protect taxpayers from future bailouts.
Mr. Obama on Wednesday compared the possible fees to the assessments that more than 8,000 banks pay the Federal Deposit Insurance Corp. to guarantee deposits. He didn’t describe what sorts of transactions might trigger the fees, though the way he described it suggests the proposal could cover exotic instruments such as credit derivatives that some believe played a key role in escalating the financial crisis. He also indicated that the fees might be levied against transactions the government wants to discourage.

It will be up to those of us who support the use of intangible assets in the capital markets to demonstrate that they are not “far-out transactions.” And the best way to do that is with gold-plated underwriting standards.

Such standards are long overdue. Maybe this current crisis will be the spur to get this done.

Changing the music business model

From time to time, I have posted items about how the music business is changing in the face of digital technology. I have argued that the business needed to — and has — shift from recording to live performance as the means of raising revenue for artist. Today’s New York Times has a story about how the recording model is changing as well — Musicians Find New Backers as Labels Lose Power. The story describes the creation of a new intermediary to take the place of the record labels. The new company, Polyphonic, will market bands over the Internet:

Under the Polyphonic model, bands that receive investments from the firm will operate like start-up companies, recording their own music and choosing outside contractors to handle their publicity, merchandise and touring.
Instead of receiving an advance and then possibly reaping royalties later if they have a hit, musicians will share in all the profits from their music and touring. In another departure from tradition in the music business, they will also maintain ownership of their own copyrights and master recordings — meaning they and their heirs can keep earning money from their music.

This is in sharp contrast to the 360 model adopted by some record labels — whereby they handle all of the artists’ promotions, including touring and merchandise as well as recordings (see earlier posting).

So after decades of a monolithic business model dominated by the record companies, we now have shifting and competing models. May the best model win. Or better yet, may diversity thrive.

Ralph Gomory on manufacturing

Last week Ralph Gomory gave an interesting talk to the New America Foundation on the need for manufacturing. Gomory is the former head of R&D for IBM and former President of the Sloan Foundation. His major point is that we need a healthy manufacturing sector to have a balances economy. I completely agree. For more information on some of the data about manufacturing and services trade, see my earlier posting on Manufacturing in the Intangible Economy.